Market watch: Bonds bear the brunt

At the end of June 2026, the outlook appeared more settled. The US and Iran had signed a memorandum of understanding (MOU). The oil price had dropped back to pre-war levels, and with it the fear of inflation subsided. Central banks were expected to keep interest rates on hold.

However, events of the past three months proved those expectations misplaced. The MOU was short-lived. Military strikes resumed, and shipping through the Strait of Hormuz remains restricted. The oil price rebounded sharply to above US$100 per barrel, especially after the Houthis escalated the conflict with attacks on Saudi oil infrastructure. In the face of far higher inflation expectations, the major central banks all reacted by hiking interest rates and signalled that more hikes may well follow.

Global stock markets, buoyed by the relentless artificial intelligence investment drive, absorbed the rate hikes well. The MSCI All World index had a positive 1.7% return over the quarter. The impact was instead felt in bond markets where yields on longer-dated bonds accelerated their already rising trend with the 10-year US Treasury yield breaching 5% for the first time since 2007 and closing the month at 5.28%. European and Japanese bond yields also moved sharply higher, resulting in negative returns for investors in these assets. The following table shows how poor the returns have been for bond investors over the past decade in all these major sovereign bond markets. The results are all for the 10-year area of the yield curve.

Our multi-asset strategies have avoided global sovereign bonds for many years because we believed yields were too low to compensate investors for the risks and did not reflect the poor fiscal positions of most major economies. Our surprise is not that yields are rising, but that the adjustment took so long. Maintaining zero exposure to this asset class has been the right stance for more than a decade. In our view, the primary problem in the global bond market is not the shorter-term inflationary pressure, but the massive build-up of government debt over the past two decades and more. Addressing it will require politicians recognise that reducing debt is essential to the economy’s long-term health. The challenge may be greater in European countries (where taxes are already high and demographic trends are unfavourable) than in the US, which has a lower tax burden and stronger demographics. Even so, persuading voters to support austerity is difficult to envisage. We are monitoring these markets closely and will reconsider investing when the combination of yields and serious attention to the fiscal deficits warrants a change in our stance.

The best route out of the debt trap in which so many countries find themselves is stronger economic growth. Government revenues will soar, and the debt metrics can improve materially, as they did in the aftermath of World War Two. It seems extremely unlikely, however, that the world is on the cusp of a growth boom. In the absence of tighter fiscal policy, higher inflation can alleviate the debt burden to a degree. Paying back debt with currency worth less than when the debt was issued is a soft option. But higher inflation also has consequences. History has shown that companies able to pass on price increases can protect their real earnings. In a world of higher inflation, full exposure to equities has historically been the best way to protect wealth.

In the South African market, resources shares rebounded after a poor second quarter and was the only sector to deliver a strong positive quarterly return. Economic growth remains weak, as reflected in the latest GDP numbers while inflation, driven by rising transportation costs, stayed well above the 3% target. The SARB had little choice but to follow global central banks with a 25-basis-point hike of its own. The so-called SA Inc. shares stayed in the doldrums. Unless economic growth surprises positively, we believe this area of the market has many value traps. The lack of topline growth remains the major problem for many domestic businesses.

Looking ahead, we have no special insights into how the geopolitical tensions in either the Middle East or the Russia-Ukraine conflict will unfold. We consequently do not base our investment case on a view of how or when these conflicts end. Artificial intelligence and the massive infrastructure spend in this area remain the single biggest influence on equity returns in the current environment. Correctly identifying the winners and losers in this technological race is a challenge, and with its short-term focus the market prices swing wildly from day to day. Our focus as always is on the long term. We own a well-diversified portfolio of stocks whose prospects we believe are underestimated.

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